The Next Financial Crisis Will Be Hellish, And It's On Its Way

Bernanke and Volcker: Different men, vastly different monetary policies

“There is definitely going to be another financial crisis around the corner,” says hedge fund legend Mark Mobius, “because we haven’t solved any of the things that caused the previous crisis.”

We’re raising our alert status for the next financial crisis. We already raised it last week after spreads on U.S. credit default swaps started blowing out. We raised it again after seeing the remarks of Mr. Mobius, chief of the $50 billion emerging markets desk at Templeton Asset Management.

Speaking in Tokyo, he pointed to derivatives, the financial hairball of futures, options, and swaps in which nearly all the world’s major banks are tangled up.

Estimates on the amount of derivatives out there worldwide vary. An oft-heard estimate is $600 trillion. That squares with Mobius’ guess of 10 times the world’s annual GDP. “Are the derivatives regulated?” asks Mobius. “No. Are you still getting growth in derivatives? Yes.”

In other words, something along the lines of securitized mortgages is lurking out there, ready to trigger another crisis as in 2007-08.

What could it be? We’ll offer up a good guess, one the market is discounting.

Seldom does a stock index rise so much, for so little reason, as the Dow did on the open Tuesday morning: 115 Dow points on a rumor that Greece is going to get a second bailout.

Let’s step back for a moment: The Greek crisis is first and foremost about the German and French banks that were foolish enough to lend money to Greece in the first place. What sort of derivative contracts tied to Greek debt are they sitting on? What worldwide mayhem would ensue if Greece didn’t pay back 100 centimes on the euro?

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See the Federal Reserve Statistical Release H.4.1 dated 1/6/11. Effectively, future losses that would result in a negative capital position on the FRB balance sheet will be reflected as a negative liability. That liability can be characterized as a receivable from the Treasury.

Actual text follows:

“The Board’s H.4.1 statistical release,”Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” has been modified to reflect an accounting policy change that will result in a more transparent presentation of each Federal Reserve Bank’s capital accounts and distribution of residual earnings to the U.S. Treasury. Although the accounting policy change does not affect the amount of residual earnings that the Federal Reserve Banks distribute to the U.S. Treasury, it may affect the timing of the distributions. Consistent with long-standing policy of the Board of Governors, the residual earnings of each Federal Reserve Bank, after providing for the costs of operations, payment of dividends, and the amount necessary to equate surplus with capital paid-in, are distributed weekly to the U.S. Treasury. The distribution of residual earnings to the U.S. Treasury is made in accordance with the Board of Governor’s authority to levy an interest charge on the Federal Reserve Banks based on the amount of each Federal Reserve Bank’s outstanding Federal Reserve notes.

Effective January 1, 2011, as a result of the accounting policy change, on a daily basis each Federal Reserve Bank will adjust the balance in its surplus account to equate surplus with capital paid-in and, in addition, will adjust its liability for the distribution of residual earnings to the U.S. Treasury. Previously these adjustments were made only at year-end. Adjusting the surplus account balance and the liability for the distribution of residual earnings to the U.S. Treasury is consistent with the existing requirement for daily accrual of many other items that appear in the Board’s H.4.1 statistical release. The liability for the distribution of residual earnings to the U.S. Treasury will be reported as “Interest on Federal Reserve notes due to U.S. Treasury” on table 10. Previously, the amount necessary to equate surplus with capital paid-in and the amount of the liability for the distribution of residual earnings to the U.S. Treasury were included in “Other capital accounts” in table 9 and in “Other capital” in table 10.

To translate into “regular guy”, if the FED goes broke they’ll call the Treasury, and the Treasury will give them T-Bills to cover their debt. The Treasury gets T-Bills by buying them from the FED. The FED causes the T-Bill to be created for the Treasury by creating money digitally and using that money to pay for a T-Bill.

Should have closed the banks and banned the bankers (including The Bernanke) when the crisis first hit. Nationalized them, cleaned them up, hired adults to run them. Instead, the kids are still in the sandbox making mud pies.

It appears that many of our basic economic theories will be tested for actual results in the coming months and years. We have been trying to manage our economy based on outdated and empirically unproven assumptions.

The worst of these ideas are those about taxes versus economic stimulus. We make various assumptions and then perform calucations that supposedly prove a point. A lot of these assumptions are critical to the calculations and without some hard data to justify the assumption allows us to make assumptions that will prove a theory.

We are currently in a situation as close to the great depression as we’ve ever been and as usual the politicans are arguing over tax cuts to stimulate the economy or a direct stimulus in the form of government deficit spending. Then the argument shifts to how much increasing the debt is going to cost us or hurt us. Has anyone ever calculated or measured the multiplier for one or the other type of stimulus. If we don’t understand how a tax cut or stimulus actually rolls through the economy, we can’t make good judgements of what it has or hasn’t done for us.

We have a lot of political stupid going around. One side says tax cuts are the key because they put money in the pockets of people who will invest it, creating new jobs and improving the economy. Sounds good, but has anyone really proven it? The other side says that approach takes too long and leaves the great majority waiting until the supposed benefits work their way through the economy to them. Their solution is to stimulate the economy at a different level, the demand level. Their idea is putting money in everybody’s pocket will stimulate demand and move the economy towards recovery faster. No one has been able to develop a solid way of measuring the actual effects of either.

The one thing we can say for sure is liquidity is king. In every serious economic downturn we’ve had since the Great Depression, the Fed has correctly kept the financial system from collapsing as it did in the 1930s by infusing real or virtual liquidity into the financial system. It has used massive infusions of liquidity into the financial system as it has done during the current crisis. In the late 1980s, program trading (currently known as computer trading) caused a huge drop in the stock markets. At that time, the whole system was in danger of collapsing as margin calls were made. At that time the New York Fed advised the major banks and brokerage firms that the Fed would provide whatever liquidity was needed to keep failures from happening. The promise of liquidity was all that was needed to keep margin calls from cratering the financial system.

Now, if we quit worrying about the Fed and concentrate on the real problem with the economy, IT’S HOUSING STUPID! Housing is moribund. It currently contributes only about half of what it did before to GDP. Unemployment in construction is above 20%. We are talking about losing something in the range of 700 billion to 1.2 trillion of direct contribution to the GDP, not ot mention the multiplier effect as it rolls through the economy.

Fix housing. Freddie Mac and Fannie Mae are not in trouble because of their structure or financial underpining, rather because of perverse incentives to senior managers resulting in gutting of underwriting criteria and the purchase or guaranteeing of bad loans. Get rid of the bad loans to a recapitalized and reactivated RTC, recapitalized Fannie and Freddie, restore intrest rates and underwriting requirements to what we know will produce sustainable results.

Working through an RTC will help to get houses sold which will help stimulate the market. The last time the RTC managed to move all the real estate they received in faster than expected turnarounds while not dragging down pricing in affected localities. That helped keep prices up and state and local tax revenues up.

A targeted stimulus at housing sufficiently large to accomplish the job, which means another amount of 1 trillion, and reconstitution of the regulatory system for mortgage investment.

Enough said, fix housing and the economy will recover. Continue to ignore it and the economy will continue to sputter for at least two more years. I’ve seen predictions for a housing recovery for spring of next year. That won’t happen if the mortgage supply system isn’t fixed.

Economic theories belong in a classroom. Economic facts are not hard to come back and basic economics isn’t a theoretical exercise. If we had practiced real economics instead of some fantacy cooked up by a Bankers and a couple of shills we wouldn’t be in this mess. Kill the FED and force the Government to print it’s own funny money. At least we won’t haver to pay interest and we can just print what we need. I time of war it has precident. Green back dollars got us through the Civil War.

The housing bubble, in part, was inflated by bottom up demand from immigration.

Somewhere along the way we’ve reached a point of diminishing returns on immigration/housing policy. US middle-class wages will not support the inflated land prices we are subject to. Both of these factors are driven by population increase, or in this case mass-immigration and related free-trade policy/agreements.

Exacerbating the problem is that the US policy has been to keep vacant housing inventory off-market for several years now with the intention of protecting investors.

So in addition to the derivative market noted in the article, housing prices have not been allowed to adjust to the new market realities.

Weaver, your suggestion that the housing bubble is in *any part* to blame on immigration is, said kindly, absurd.

The housing bubble occurred for two reasons on the demand side – A) the ease of obtaining a loan B) speculators who didn’t believe prices would go anywhere but up (I knew many of these people).

People were buying multiple homes, leveraging everything they could to do so.

And on the supply side . . .

Go visit Arizona and you will see thousands and thousands of homes sitting empty.

Even during the boom (and I don’t pretend that I *saw* the burst coming) I was asking “Where are all these people going to come from to live in these homes?”

Developers WAY over built in hopes of exploiting the situation. I should expect that all of the places hit hardest are also the places that were most OVER built.

If there was any sense of shortage that drove up prices it was on the part of people seeking to buy as much property as they could without any consideration that SUPPLY far outweighed the demand. That, in large part, is why the bubble burst.

Excellent. I don’t know why all Americans aren’t livid. It a perfect world all of the miscreants at the FED would be hanging in a tree right along with the Majority of Congress, who are the single largest collection of morons ever assembled in one place in the entire history of mankind. ! To bad this ins’t a perfect world.

Alright, I’ll go along with “The Fed cannot be wiped out”, and I’ll accept the point of “liquidity” being the saving grace of past economic disasters. But where is the money? Or better yet, does it even exist anymore? Have we not lost 7% of our currency value in the last year? What and where do we go from here? Or, do we?

Just how bad will it get? From what I have just read here I can only assume “real bad”. When the three cries of history replay themselves again then I think we will be at the bottom. (Refer to Grapes of Wrath- Steinbeck for the three cries)

The coming economic collapse will be global and severe. Representatives from the world’s largest economies (G8 or G20 or similar) will gather to analyze the crisis. They will conclude that global financial regulation was non-existent or insufficient to control the bubbles in sovereign debt, electronic trading, derivatives, etc. Sovereign nations will concede financial regulation to a global governing body (IMF?) and the world will have a global financial regulatory authority in a very short time; a world Fed.

Fear of a global economic collapse is insufficient motivation for sovereign nations to concede their financial regulatory authority to a world Fed. Creation of a global financial regulatory authority will only be possible after a global economic collapse. Your social security or tax ID number will be your account number. Every transaction will include this number. Ours is the first generation to see computer technology sufficient to track 7 billion global account numbers.

All this could start in motion any day now. Not to worry, there will be sufficient food, water and clothing. Anything more than that is a luxury anyway. Just ask the poorest one billion people among us.

Nopthing alters the fact that we have private shylocks controling our money and our economy and answerable to no one. We have no money. We have debt and the only way to get more currency ( Bank Notes )is to borrow from shylock. Bank notes are currency and legal tender, but they aren’t money and they represent nothing what so ever than debt. Americans are all Lunatics to think that this is anything but servatude.

I paid $32.67 for a XBOX 360 and my mom got a 17 inch Toshiba laptop for $94.83 being delivered to our house tomorrow by FedEX. I will never again pay expensive retail prices at stores. I even sold a 46 inch HDTV to my boss for $650 and it only cost me $52.78 to get. Here is the website we using to get all this stuff, BidsNew.com

This went viral–its great! If every American (or even just one in 5) each sent a one-time $10.00 check to the US treasury to pay down the interest on our national debt (stipulate this in the check memo) in 72 hours the US treasury would have well over .5 trillion dollars to use on the debt. Great! This now allows a matching amount of capitol to come out of the treasury, which, can be SPENT on saving America. Now there is money for programs, Seniors jobs–what an economic stimulus it is–One made by and for the people of the grand USA.

I sent my $10.00 check to the same address where I send my Fed Tax forms. Amazingly–They are even asking Pres. Obama to write out a $10.00 check–they are asking all of Congress to write out one-time $10.00 checks.

Bring the troops home,use the money Americans send in–to fix what’s apparently temorarily WAY TOO BROKEN. Thanks America for doing something. We Can do something Get out of “learned helplessness mode and write that check right now. Money talks.

“Around the corner” and this is 2 years old now, and we’re still saying the same thing. Mighty long corner. :) OTOH we underestimated how much debt the EU, US, and Asia could take on in the meantime. And we still have little idea how much hidden debt is in China, or what that inevitable bubble pop will be like with the world’s second and third largest economies.

I wish I could find the paper to post here. An economist a few years ago had the right idea. Instead of TARP and other b/s schemes he had figured if every tax payer (filed) was given $100,000 first money to be paid towards their mortgage and then the excess refunded to them the cost would have been 1/2 of TARP and the country would have been far ahead. He was the first person I ever saw who wanted a bailout that at least made sense. Lenders would have been paid and people not foolish enough to have bought more then they could afford would have spending cash.

Of course to people like me let the foolish investors all fail including the lenders, most failed anyways and people lost their homes as well